Mr BALDWIN(11.03)
—As we are now considering the allocation of funds to the Department of the Treasury it is appropriate-albeit within very severe time constraint-to consider briefly the role that this Department has come to play and, in particular, the nature of the economic advice that it is giving the Government. The allegation has been made for some time now that, far from being a relatively neutral instrument amenable to and equally co-operative with governments of different persuasions, Treasury has a definite 'line' of its own where economic policy is concerned.

It is said that the Department of the Treasury, or at least that part of it charged with the responsibility of formulating advice on economic policy, is wedded to certain strong views about economic reality and that, when governments diverge too much from this, unpleasant consequences can follow. Allegations of this type were made in respect of the relationship between Treasury and the Whitlam Government. But, interestingly enough, matters also came to a head with the Fraser Government when it decided to move away from severe macro-economic contractionism in last year's Budget. That Budget, of course, saw some abandonment of ideological principle on the part of the Fraser Government- luckily for the people of Australia. The rhetoric about winding back the deficit was ditched to some degree in preparation for the coming election.

If the Valder report of the Liberal Party Committee of Review released last week setting future directions for the Liberal Party is to be taken seriously- and the Leader of the Opposition (Mr Peacock) has apparently embraced its main recommendations-we can expect to see the application of a much more doctrinaire line from the Opposition in future on such matters. This spells grim times ahead if it ever succeeds in regaining government. We all remember the episode after last year's Budget when the Secretary to the Treasury, the redoubtable John O. Stone, wrote a critical letter to the journal Australian Business pointing to the unfortunate consequences that befall governments that 'stop listening to the Treasury' with special reference to the fate of the Whitlam Government. This was a clear warning to Mr Fraser to toe the line. Even the former Treasurer, now Deputy Leader of the Opposition, was moved to say on 31 August last year at a National Press Club luncheon-this quote is from a transcript available in the Parliamentary Library:

. . . they tend to see things in terms of only one option, and occasionally a few shades of grey would achieve a better result, and they occasionally don't like any breaking down of the monopoly on advice.

Despite all this, Mr Howard concluded:

. . . but I retained a very warm regard for them.

All this precipitated a major debate about the role of Treasury and Mr Stone in particular. As a consequence, when Labor took office it was widely suggested that Mr Stone be replaced with someone less hostile to the broad thrust of Labor 's economic strategy. The economics editor of the Sydney Morning Herald, Ross Gittins, for one, expressed the view that failure to replace Mr Stone in the immediate post-election period when there was a general public expectation of such a move would, in future years, be regarded as one of the most serious errors made in the early period of this Government. I frankly concur with that view.

I referred above to the existence of a Treasury line on macroeconomic policy. The Department of the Treasury, of course, has no line in the sense of an official policy. That is supposed to be the prerogative of the Government of the day. Furthermore, there obviously exist some differences of view among individual Treasury officers. Nonetheless, I maintain that it is appropriate to talk of a Treasury line. The nature of this can be ascertained by looking at the views on policy matters expressed by John Stone. I do not believe that this overstates the importance of one individual. The personal intellectual dominance of Mr Stone in the Department is generally recognised. This view is confirmed by an examination of Budget Statement No. 2 'The Budget and the Economy'. While this document supposedly reflects the policy of the Government of the day, it is drafted in the first instance by Treasury, and Treasury's central obsessions, particularly in respect of the importance of inflationary expectations and the role of monetary policy, come through loud and clear. Views on these matters lie at the heart of Treasury's aversion to expansionary fiscal policies as a means of stimulating real output and reducing unemployment. Mr Stone's views on these matters are set out in a paper 'The Budget Deficit and the Economy' published in a volume of articles on this subject by the Centre for Applied Economic Research at the University of New South Wales in 1979. His paper begins:

The view to be put in this paper is that, in current economic circumstances in Australia, a policy of expanding the Budget deficit, whether by increased government spending or by reduced taxation, would not achieve the ends to which it would presumably be directed. That is it would not lead to expanded output and employment and reduced unemployment, at least in any sustained sense, but rather would darken prospects in those areas.

He concedes the existence of conventional Keynesian multiplier effects from a fiscal stimulus. He then argues:

. . . in present circumstances such analysis does not tell the whole story. The additional factors which must be taken into account, and which would, in aggregate, more than offset any narrowly defined multiplier effects are the monetary effects of the deficit, effects on the balance of payments, effects on wage determination, and the effects-both direct and through these channels-of the Budget deficit on confidence and expectations in the economy at large. In this latter regard the rate of inflation and changes therein are seen as having a key role.

Mr Stone contends that heightened inflationary expectations engendered by large Budget deficits lead to reduced consumption and investment expenditures. These are highly controversial propositions in regard to which there is considerable economic literature. All that I can do in the space of a short speech is to indicate this by quoting from another respected Australian authority in the area of fiscal policy, Professor John Nevile, of the University of New South Wales. He prepared for the Parliamentary Library earlier this year a paper that refers to these matters: 'Macroeconomic Issues and Policy Options'. I will give a couple of quotations to contrast Professor Nevile's views with those of Mr Stone . On the linkage between fiscal expansionism and inflationary expectations Professor Nevile says:

Stone's argument that expansionary fiscal policy will cause expectations that the rate of inflation will rise is speculation not fact. Any effect on inflationary expectations will only be in this direction, but there is no evidence that this effect is large.

On the further link between inflationary expectations and investment expenditure , he says:

However, if the past can be taken as a guide to the future, actual inflation, let alone expectations of inflation, will not reduce investment by anything like the extra expenditure induced by expansionary fiscal policy, unless the expansionary fiscal policy is accompanied by a very substantial rise in interest rates.

The strength of any link between deficits and interest rates-insofar as one asserts the existence of a strong link-hinges crucially on the monetary policy stance being pursued. Labor has traditionally taken the view that a more liberal monetary policy will attenuate any adverse interest rate consequences of fiscal expansionism. Treasury opposes this on the conventional monetarist ground that this will be inflationary. Again, the link between monetary growth and inflation is one of the points on which monetarism has been attacked, and this is a major economic controversy in itself. It is clear that the type of thinking in the above quotations from Mr Stone has exerted a major influence on the economic analysis in Budget Statement No. 2 'The Budget and the Economy'. I will quote from page 57 of this statement:

In reality, fiscal policy can affect the economy through a variety of channels in addition to direct income/ expenditure effects. It can influence interest rates, exchange rates, the money supply, the balance of payments, expectations- notably, inflationary expectations-confidence and uncertainty. These additional transmission mechanisms are, for the most part, extremely inconvenient to handle analytically and often impossible to quantify. They are, however, no less real for being empirically and often even theoretically intractable.

A comparison of this quotation with the second quotation above from Mr Stone's paper shows an almost identical appraisal of the role of inflationary expectations and their importance for the efficacy of fiscal policy. The main point of difference is that Mr Stone's paper makes no bones about asserting that the overall effect of fiscal stimulus on real output would be negative, whereas the quotation from Budget Statement No. 2 talks vaguely about how the expectational effects are 'difficult to quantify' but are 'no less real' for that. In respect of monetary policy, likewise, a monetarist line emerges. I will quote again from Budget Statement No. 2:

To recapitulate, I contend that it is meaningful to talk of a Treasury line in economic policy. This is most clearly set out in the writings of John Stone. It is a conservative line, hostile to fiscal expansionism and based on a view of economic relationships that is vastly contentious and, I believe, false. The influence of this thinking is clearly evident in Budget Statement No. 2 which is drafted by Treasury. I say these things because it is imperative that the Government is at least aware of the sort of ideological bias that can creep into the advice it receives.